Abstract: Recently, Performance-based Contracts (PBC) have become a prevalent business model in the after-sales service area. Traditionally, the supplier receives payment based on providing failure repair activities and selling parts. However, under PBC the supplier is compensated based on realized product availability. Hence, the supplier needs to reconsider its operational decision to increase product uptime and avoid under-performance penalty. Spare parts are key to product failure repair and its availability affects repair rate and final product performance. When components face obsolescence risk, resourcing spare parts may become unfeasible and thus inventory management for obsolete parts is of highly importance. In this paper, a game-theoretic model is built to capture a setting when product quantity and PBC terms are contracted between a supplier and a customer. Two different penalty schemes in PBC are considered- penalty based on spare parts stockout (PBC-B) vs. penalty based on lost revenue caused by system downtime (PBC-L). It can be found that that these two types of PBC lead to divergent equilibrium outcomes. The analytical results and numerical experiments demonstrate that PBC-L provides a stronger incentive for the supplier to improve product availability. However, in contrast to PBC-B, PBC-L may lead to overinvestment in spare parts and a lower product quantity, which can result in lower profits for the supply chain partners. Our model and results shed lights on how to design and implement PBC contracts for aftersales service and provide insights for customers on how to design incentive punishment mechanism to motivate suppliers.

Key words: product repair; after-sales service; performance-based contracts; component obsolescence; supply chain game