Contracting for Collaborative Services

TLDR

The paper analyzes contracting issues in collaborative services and investigates how contract type choice is driven by service environment characteristics. The authors examine how contract type choice and performance are influenced by service environment characteristics, output uncertainty, process improvement opportunities, and multi‑party involvement in joint production. They find that fixed‑fee contracts contingent on performance are preferred when vendor effort dominates, time‑and‑materials when buyer effort dominates, and performance‑based contracts when both parties influence output; the model also highlights trade‑offs and identifies process design changes that improve contract efficiency.

Abstract

In this paper, we analyze the contracting issues that arise in collaborative services, such as consulting, financial planning, and information technology outsourcing. In particular, we investigate how the choice of contract type—among fixed-fee, time-and-materials, and performance-based contracts—is driven by the service environment characteristics. We find that fixed-fee contracts contingent on performance are preferred when the service output is more sensitive to the vendor's effort, that time-and-materials contracts are optimal when the output is more sensitive to the buyer's effort, and that performance-based contracts dominate when the output is equally sensitive to both the buyer's and the vendor's inputs. We also discuss how the performance of these contracts is affected with output uncertainty, process improvement opportunities, and the involvement of multiple buyers and vendors in the joint-production process. Our model highlights the trade-offs underlying the choice of contracts in a collaborative service environment and identifies service process design changes that improve contract efficiency.