Optimal Cost Avoidance Investment and Pricing Strategies for Performance-Based Post-Production Service Contracts
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Authors
Nowicki, David
Ramirez-Marquez, Jose
Randall, Wesley
Murynets, Ilona
Subjects
Performance Based Management
PBC, Performance-Based Contracting, Capital-Intensive Systems, MRO, ROI, ROS
PBC, Performance-Based Contracting, Capital-Intensive Systems, MRO, ROI, ROS
Advisors
Date of Issue
2011-04-30
Date
30-Apr-11
Publisher
Monterey, California. Naval Postgraduate School
Language
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''s needs. The model accounts for reliability as a function investment, the average and variance of the cost to perform maintenance tasks, and for customers'' willingness to pay for a contract depending on its length. Numerical examples illustrate how optimal strategies depend on potential market size, expected cost per failure, and on other parameters of the model.
Type
Report
Description
Proceedings Paper (for Acquisition Research Program)
Series/Report No
Department
Acquisition Management
Organization
Identifiers
NPS Report Number
NPS-AM-11-C8P21R01-071
Sponsors
Acquisition Research Program
Funder
Format
Citation
Distribution Statement
Approved for public release; distribution is unlimited.
Rights
This publication is a work of the U.S. Government as defined in Title 17, United States Code, Section 101. Copyright protection is not available for this work in the United States.