Outcome-Based Contracts as a Sine Qua None for Complex Industrial Services?

 We’re pleased to welcome authors Eva Böhm of PaderbornUniversity, Christof Backhaus of Aston Business School, Andreas Eggert of PaderbornUniversity, and Tim Cummins of IACCM (International Association for Contractand Commercial Management). Their paper Understandingoutcome-based contracts: Benefits and risks from the buyers’ and sellers’perspective won the JSCAN Best Paper Awardand is currently free to read for a limited time. Below, they briefly writeabout the motivation and impact of their research.

What motivated you to pursue this research?

Many businesses nowadays not only offer basic after-sales services, like repair or maintenance, but also operate entire processes on their customers’ behalf. When buyers and sellers negotiate and arrange for such complex customer solutions, so called outcome-based contracts are increasingly made use of. Outcome-based means that suppliers get paid based on the realized outcome of the service or solution (e.g., the time a machine runs without breakdown) as opposed to the resources invested by the supplier (e.g., time and material). Rolls Royce’s “Power by the Hour”, Michelin’s Fleet Solutions, and BASF’s Coatings are frequently cited prototypes for industrial services and solutions that build on such outcome-based contracts.
While outcome-based contracts have a longer history in markets such as airlines, defense, logistics, and also health care and public services, suppliers in diverse industries are now experimenting with this new business model. Given that empirical research on outcome-based contracts is still comparatively scarce, we were interested in finding out how both buyers and sellers assess two particular types of outcome-based contracts – that is contracts based on a payment for availability (aOBC) vs. contracts based on a payment for economic results (eOBCs) logic – with regard to associated benefits and risks and also their overall performance.

In what ways is your research innovative?

Although providing valuable insights, existing studies on outcome-based contracts are limited in three respects: First, outcome-based contracts are mainly looked at from the customer’s perspective, while the supplier’s perspective is often ignored. Second, while the existence of different types of outcome-based contracts has been acknowledged, there is no study investigating differential outcomes. Third, empirical verifications of the effectiveness of outcome-based contracts under specific contextual circumstances are largely missing. In light of these gaps, it was our goal to provide a finer-grained view on the bright and dark sides of outcome-based contracts from both the customers’ and the suppliers’ perspective. Also, we took into account two important context characteristics, that is, product innovativeness and technological turbulence, to see how the picture looks like under varying market conditions. With the help of the International Association for Contract and Commercial Management (IACCM), who distributed our survey among its members, it was possible to collect a relatively large sample of 259 buyers and sellers using OBCs in complex industrial services, which allowed us to empirically test our assumptions.

How do you think your research will impact on the field?

From a theoretical perspective, our results highlight the need to differentiate between the different perspectives on outcome-based contracts. According to our results, advantages of the use of a particular contractual arrangement for one exchange partner do not necessarily correspond with advantages for the other one. For managers, our findings help to better decide which type of outcome-based contract promises to be most beneficial under the given contextual conditions. For example, we could show that outcome-based contracts based on economic results should be the preferred option when contractual arrangements regarding established and well-understood products are made in highly turbulent environments. Here, the net benefit of shifting comparatively higher levels of responsibility to sellers is highest for both parties.

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