Incentive issues in performance-based outsourcing contracts in the UK defence industry: a simulation study

Abstract

Traditional outsourcing literature has claimed gains for the customer in terms of quality and costs. However, such gains are illusory in outsourcing of high-risk, complex tasks. The use of contracts and governance mechanisms for handling complex procurements is essential in obtaining rewards from outsourcing. Powerful incentives and risks are normally used in industrial service contracts to transfer risks to measure compliance with performance measures. The availability contracts for complex engineering services provision are forms of outsourcing contracts that transfer resources from government to external service providers on a substantial scale. The change moves the contractor role from creating resources to managing resources. Such role change mandates collaboration with customers and suppliers in supply/value chains. The management task is then perceived in terms of linking and optimising alignments rather than increasing service levels. Incentive design is one mechanism for linking the coordination of resources required in availability contracting to the business model. This article studies the impacts of agreed contract type and incentive mechanism on the customer and service provider profits using agent-based discrete event simulation model under multiple risk sharing scenarios.

Keywords:

• public sector outsourcing
• availability contracts
• incentives
• simulation
• performance-based contracts

Acknowledgements

A part of this research is jointly funded by British Aerospace Systems Plc and Engineering and Physical Science Research Council (EPSRC), the UK and conducted as part of the Support Service Solutions: Strategy and Transition (S4T) project consortium led by University of Cambridge. A significant part of the simulation is carried out with research funding from Indian Institute of Management, Calcutta.