Contracting for Infrequent Restoration and Recovery of Mission-Critical Systems

Firms that rely on functioning mission-critical equipment for their businesses cannot a¤ord signi…cant 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 since 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, due to 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...

• Type: Journal
• Year: 2010
• Where: MANSCI
• Authors: Sang-Hyun Kim, Morris A. Cohen, Serguei Netessine, Senthil K. Veeraraghavan
• Keywords: Downtime, Incentive Mechanism, MANSCI 2010, Proper Incentive Mechanism