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

36 Pages Posted: 12 Apr 2011

See all articles by Jose Guajardo

Jose Guajardo

University of California, Berkeley

Morris A. Cohen

University of Pennsylvania - The Wharton School

Sang-Hyun Kim

Yale School of Management

Serguei Netessine

The Wharton School, University of Pennsylvania

Date Written: April 11, 2011

Abstract

Using a proprietary dataset provided by a major manufacturer of aircraft engines, we empirically investigate how product reliability is impacted by 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 on product reliability created by the incentives under PBC. 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 accounted for. Our results are consistent with two mechanisms for reliability improvement under PBC: more frequent scheduled maintenance and better care performed in each maintenance event.

Suggested Citation

Guajardo, Jose and Cohen, Morris A. and Kim, Sang-Hyun and Netessine, Serguei, Impact of Performance-Based Contracting on Product Reliability: An Empirical Analysis (April 11, 2011). INSEAD Working Paper No. 2011/49/TOM. Available at SSRN: https://ssrn.com/abstract=1807049 or http://dx.doi.org/10.2139/ssrn.1807049

Jose Guajardo

University of California, Berkeley ( email )

310 Barrows Hall
Berkeley, CA 94720
United States

Morris A. Cohen

University of Pennsylvania - The Wharton School ( email )

Philadelphia, PA 19104
United States

Sang-Hyun Kim

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

Serguei Netessine (Contact Author)

The Wharton School, University of Pennsylvania ( email )

3730 Walnut Street
Philadelphia, PA 19104-6367
United States
(215) 573 3571 (Phone)

HOME PAGE: http://www.netessine.com

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