Who Should Bear the Risk? A Theoretical and Behavioral Investigation of After-Sales Service Contracts

Since downtime is expensive, it is key to use the right after-sales service contract to achieve high equipment availability. Resource-based contracts (RBCs) are common, but they fail to motivate suppliers to provide reliable products and services as suppliers are paid for their after-sales services. Performance-based contracts (PBCs) have been proposed as a way to solve this issue, as it shifts much of the downtime risk to the supplier by making him responsible for machine uptime, but then customers might reduce care efforts. We are the first to analytically incorporate the care in equipment availability. We propose the full-care contract (FCC) to achieve both high reliability and care, and maximize the chain efficiency. We find that only the FCC can achieve full chain efficiency. After discussing potential behavioral factors in this context, with a focus on risk aversion, we conduct a lab study with decision makers as suppliers. Experimental results confirm that the FCC achieves higher total profits than the PBC and RBC. We further find that subjects are more likely to switch from the RBC to the FCC than to the PBC, despite the higher risk involved in the FCC. Finally, we observe that effort levels set by suppliers are above normative predictions and we discuss potential explanations for this result