The economic impact of such service contracts is significant.
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In the commercial aerospace sector, for instance, PBL has become a standard contract provision for the support of such key sub-systems as aircraft engines and avionics systems. economy.” The study goes beyond the traditional maintenance contracts that are used for relatively simple products like automobiles or electronics, looking instead at contracts for mission-critical products in capital-intensive industries such as aerospace and defense, which include the maintenance and repair of all classes of military and commercial aircraft as well as defense equipment. The researchers focused on contracts related to support and maintenance services, which they say “constitute a significant part of the U.S. “Not only does it pose theoretically challenging questions, but also insights gained from the analysis are of great interest to practitioners who are currently undergoing major business process changes due to the move towards PBL contracting.” “Performance-based contracting in service supply chains offers a fertile ground for research where economics and classical inventory theory converge naturally,” they write. In a recent paper titled, “Performance Contracting in After-Sales Service Supply Chains,” Netessine, Cohen and Kim analyzed performance-based relationships by putting different contracting considerations under the microscope in a principal-agent analytical model. It’s intuitive - the optimal contract is really a combination of three things: fixed payment or fixed price, cost-sharing and performance-based compensation.” Third, you want to achieve the greatest performance possible. “First, the contract should give the supplier the incentive to reduce costs. “What kind of contract do you want to structure for suppliers?” Netessine asked a recent gathering of aerospace and defense industry representatives at the 2006 Wharton Service Supply Chain Thought Leaders Forum. And, if their future analysis of risks and incentives in contracting holds true, they predict that the optimal customer-supplier relationship will be realized by combining performance-based contracting with elements of more traditional service agreements. Without doubt, they argue, this new strategy is fast becoming an important component of the management of after-sales service supply chains, with implications that potentially reach beyond defense and aerospace contracting, and into certain retail sectors. Cohen and Serguei Netessine, and doctoral student Sang-Hyun Kim, performance-based contracting may also “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.”
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According to a recent paper and conference presentation by two Wharton professors of operations and information management, Morris A. A major focus of these efforts involves re-designing the contractual and implicit relationships between customers and suppliers in the service support supply chain.Īt the heart of PBL is the notion that risks and incentives should be more equitably aligned between suppliers and customers than has been possible under traditional “fixed-price” or “cost-plus” contracts. Customers and suppliers of mission-critical products, such as semi-conductor manufacturing equipment, commercial aircraft and military weapon systems, are recognizing that the acquisition of world-class products is not sufficient, but rather it is necessary to provide superior, cost effective maintenance and support services throughout the after-sales phase of the customer-supplier relationship.
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Known as “Power by the Hour” (PBH) in the private sector, this new approach is already reshaping customer-supplier relationships in defense and aerospace contracting under the name “Performance-based Logistics” (PBL). That might sound far-fetched, but it could be the future model for purchases requiring service over time. Imagine paying for your car only when it works.