Optimal Cost Avoidance Investment and Pricing Strategies for Performance-Based Post-Production Service Contracts

Report Number: NPS-AM-11-C8P21R01-071

Series: Acquisition Management

Category: Performance Based Management

Report Series: Proceedings Paper

Authors: David Nowicki, Jose Ramirez-Marquez, Wesley Randall, Ilona Murynets

Title: Optimal Cost Avoidance Investment and Pricing Strategies for Performance-Based Post-Production Service Contracts

Published: 2011-04-01

Sponsored By: Acquisition Research Program

Status: Published--Unlimited Distribution

Research Type: Other Research Faculty

Full Text URL: http://acquisitionresearch.net/files/FY2011/NPS-AM-11-C8P21R01-071.pdf

Keywords: PBC, Performance-Based Contracting, Capital-Intensive Systems, MRO, ROI, ROS

Abstract:

Performance-based contracting (PBC) is altering the fundamental relationship between buyers and suppliers engaged in the support of capital-intensive systems such as high-speed rail, defense, and power generation. This relationship is shifting from a traditional transactional-based (return on sales) business approach to a collaborative, performance-based (return on investment) multi-year contractual model. With PBC, the supplier is compensated for system performance rather than for each maintenance, repair, and overhaul (MRO) transaction. PBC success lies in the incentive structure. Under PBC supplier profits, system performance and operator costs are improved when smart investment decisions are made that trade year after year MRO costs for upfront investments that reduce total cost of ownership.
This paper develops a decision-theoretic model that determines the optimal contract length and optimal investment and pricing strategies for performance-based, post-production service contracts that simultaneously maximizes the profit to the supplier while satisfying the customer