Negotiation for service contracting: incentives, bargaining power, and customer risk aversion.

In this paper, we analyze negotiation of service contracts when an equipment user (customer) outsources product failure repair service to an MRO (Maintenance, Repair, and Overhaul) supplier. The customer is risk averse due to serious consequences of system disruption. The two parties negotiate pricing terms and repair rate. We model the bilateral negotiations under three types of service contract: (i) fixed‐fee contract under which the customer pays a lump sum, (ii) pay‐per‐repair contract under which the customer pays for each repair incident, and (iii) uptime‐based contract under which the customer pays for product uptime. We investigate how different incentives under each contract interact with agents' bargaining power and customer risk aversion in the negotiation process, both theoretically and numerically. Despite that previous studies have shown that fixed‐fee contract generally does not provide incentives for suppliers to invest in repair capacity while uptime‐based contract does, we find that under a bargaining framework fixed‐fee contract can result in the highest (yet suboptimal) repair rate. Furthermore, consensus on contract types may not be achieved between the two parties. For the supplier, uptime‐based contract can result in the highest payoff while pay‐per‐repair contract leads to the lowest. For the customer, it may prefer to choose pay‐per‐repair contract when it is less risk averse and when the supplier has more bargaining power. Our results show some unexplored merits of other types of contracts when the advantages of uptime‐based contract have been highly cited. [ABSTRACT FROM AUTHOR]