Access

You are not currently logged in.

Access your personal account or get JSTOR access through your library or other institution:

login

Log in to your personal account or through your institution.

Contracting for Infrequent Restoration and Recovery of Mission-Critical Systems

Sang-Hyun Kim, Morris A. Cohen, Serguei Netessine and Senthil Veeraraghavan
Management Science
Vol. 56, No. 9 (September 2010), pp. 1551-1567
Published by: INFORMS
Stable URL: http://www.jstor.org/stable/40864658
Page Count: 17
  • Download ($30.00)
  • Cite this Item
Contracting for Infrequent Restoration and Recovery of Mission-Critical Systems
Preview not available

Abstract

Firms that rely on functioning mission-critical equipment for their businesses cannot afford significant operational downtime due to system disruptions. To minimize the impact of disruptions, a proper incentive mechanism has to be in place so that the suppliers provide prompt restoration and recovery services to the customer. A widely adopted incentive mechanism is performance-based contracting (PBC), in which suppliers receive compensation based on realized system uptime. A key obstacle is that disruptions occur infrequently, making it very expensive for a supplier to commit the necessary resources for recovery because they will be idle most of the time. In this paper, we show that designing a successful PBC creates nontrivial challenges that are unique to this environment. Namely, because of the infrequent and random nature of disruptions, a seemingly innocuous choice of performance measures used in contracts may create unexpected incentives, resulting in counterintuitive optimal behavior. We compare the efficiencies of two widely used contracts, one based on sample-average downtime and the other based on cumulative downtime, and identify the supplier's ability to influence the frequency of disruptions as an important factor in determining which contract performs better. We also show that implementing PBC may create high agency cost when equipment is very reliable. This counterintuitive situation arises because the realized downtimes from which the customer might intuit about the supplier's capacity investment are highly uncertain when there are not many samples of downtimes, i.e., when disruptions occur rarely.

Page Thumbnails

  • Thumbnail: Page 
1551
    1551
  • Thumbnail: Page 
1552
    1552
  • Thumbnail: Page 
1553
    1553
  • Thumbnail: Page 
1554
    1554
  • Thumbnail: Page 
1555
    1555
  • Thumbnail: Page 
1556
    1556
  • Thumbnail: Page 
1557
    1557
  • Thumbnail: Page 
1558
    1558
  • Thumbnail: Page 
1559
    1559
  • Thumbnail: Page 
1560
    1560
  • Thumbnail: Page 
1561
    1561
  • Thumbnail: Page 
1562
    1562
  • Thumbnail: Page 
1563
    1563
  • Thumbnail: Page 
1564
    1564
  • Thumbnail: Page 
1565
    1565
  • Thumbnail: Page 
1566
    1566
  • Thumbnail: Page 
1567
    1567