Availability-Based Real Options Approach for Determining the Cost and Pricing of Performance-Based Logistics Contracts
Abstract
Performance-based logistics (PBL) is growing in popularity for both governmental and nongovernmental acquisitions of critical systems. These contracts allow the customer to buy the performance of the system rather than purchase the system, and/or to buy the availability of the system rather than pay for maintenance. Performance-based contracts are not warranties, lease agreements, or maintenance contracts, which are all “break-fix” guarantees, rather these contracts are highly quantified “satisfaction guaranteed” contracts where “satisfaction” is defined by the outcomes received from the system, usually articulated as a time (e.g., operational availability). Unfortunately, the contract design (if done at all) is always performed separate from the engineering design process and provided (best case) as a requirement to the engineering design process. This process (or lack of process) creates significant risks for all parties. For systems that are subject to performance-based contracts, contract failure may mean hundreds of millions of dollars spent by the customer (potentially the public) for either no outcome or inadequate outcome, or result in the contractor being driven out of business, which can lead to disaster for both parties. We approach contract design as a system design problem where the process of designing contractual terms that address performance metrics, the payment model, and performance assessment, represents a multidisciplinary design process that can be integrated into the broader engineering design process. This approach requires: (1) modeling the system under contract; (2) developing a pricing model; (3) simulating system parameters under both the contract model and pricing model to obtain (4) a payment model; and finally (5) exploring the design space. This project addresses only step (3) of this design process where a simulation-based real options pricing model for PBL will be developed.
Document Details
- Document Type
- DoD Grant Award
- Publication Date
- Mar 09, 2016
- Source ID
- N002441610003
Entities
People
- Peter Sandborn
Organizations
- Office of the Secretary of Defense
- University of Maryland