Contracting outsourced services with collaborative key performance indicators

Akkermans, H, van Oppen, W, Wynstra, F and Voss, C A (2019) Contracting outsourced services with collaborative key performance indicators. Journal of Operations Management, 65 (1). pp. 22-47. ISSN 0272-6963

Abstract

While service outsourcing may benefit from the application of performance-based contracts, the implementation of such contracts is usually challenging. Service performance is often not only dependent on supplier effort but also on the behavior of the buying firm. Existing research on performance-based contracting provides very limited understanding how this challenge may be overcome. This paper describes a design science research project that develops a novel approach to buyer-supplier contracting, using collaborative Key Performance Indicators (KPIs). Collaborative KPIs not only evaluate and reward the supplier contribution to customer performance but also the customer’s behavior to enable this. In this way, performance-based contracting can also be applied to settings where supplier and customer activities are interdependent, while traditional contracting theories suggest that output controls are not effective under such conditions. In the collaborative KPI contracting process, indicators measure both supplier performance and customer (buying firm) performance, and promote collaboration by being defined through a collaborative process and by focusing on end-of-process indicators. The paper discusses the original case setting of a telecommunication service provider experiencing critical problems in outsourcing IT services. The initial intervention implementing this contracting approach produced substantial improvements, both in performance and in the relationship between buyer and supplier. Subsequently, the approach was tested and evaluated in two other settings, resulting in a set of actionable propositions on the efficacy of collaborative KPI contracting. Our study demonstrates how defining, monitoring, and incentivizing the performance of specific processes at the buying firm can help alleviate the limitations of traditional performance-based contracting when the supplier’s liability for service performance is difficult to verify.