Abstract

Using a proprietary dataset provided by a major manufacturer of aircraft engines, we empirically investigate the impact of incentives present in after-sales repair and maintenance support contracts on product reliability. In particular, we compare the reliability of products under time and material contracts (T&MC), which have been used traditionally in the aerospace industry, with the reliability under performance-based contracts (PBC), which are gaining wide acceptance. Adverse selection of customers into contract types, and consequently the endogeneity of contract choice, is explicitly modeled by means of a two-stage econometric model. After controlling for this selection process, we find evidence for the positive and significant effect of performance incentives created by PBC on product reliability. We test this hypothesis using a number of reliability proxies, alternative model specifications, and we perform a number of robustness checks. Our estimates indicate an improvement of product reliability in the 20-40% range under PBC, compared to the reliability observed under T&MCs. Our research provides a valuable input into the ongoing policy debate about the effectiveness of performance-based maintenance contracts which are currently being introduced extensively in both the government and the private sectors. 1

Citations