Performance-based contracting in military supply chains and the willingness to bear risks

Abstract

Purpose: Performance-based contracting (PBC) plays an increasingly important role in the defense industry. This paper aims to investigate factors that influence service provider’s willingness to accept PBC-induced risks. It also shows how these risks could be managed in a military service supply chain. Design/methodology/approach: The case study focused on the relationship between a service provider and a customer that acted on behalf of other users in the defense sector. The contract involved the sustainment of a military engine in a complex supply chain. Findings: The service provider’s performance attributability appeared to have a strong impact on its willingness to take PBC-induced risks. For the parts where the service provider did not have full control over the service performance, exclusions and Service Level Agreements (SLAs) were used to manage and mitigate the risks associated with uncontrolled performance. The service provider’s willingness to accept PBC-induced risks was also affected by its ability to make accurate forecasts, the applied growth path and the length of the contract. Research limitations/implications: This case has specific characteristics, unique by time (maturity of the technical system and supply chain) and place (market). It is recommended that results are tested in other research settings. Practical implications: Organizations should be aware of the factors that influence a service provider’s willingness to bear PBC-induced risks. Customers should limit PBC to those parts of a contract where risks are of an acceptable level. Also, it is recommended to follow a phased growth path when it is not possible to make accurate forecasts in a PBC context. Originality/value: This study is the first to address critical issues concerning the identification and management of risks under PBC in the defense industry.