Contracting Performance

Contracting Potentials And Risk

The contract formation process is very important for manufacturing firms that wish to develop their service business. A “very good” service contract may have negative effects on product sales.

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In traditional contracts for capital goods, the initial purchasing of a system and the subsequent life cycle support are usually procured separately. For example, costs associated with maintenance-repair-overhaul (MRO), are seen as inevitable by buyers. Performance-based or outcome-based contracts peg the provider’s remuneration with specific performance metrics. Thus customers do not pay for activities or tasks but pay for outcomes/jobs to be done.

Types of Contracts

By using new contracting mechanisms, providers take over what used to be the responsibility of their customers. This allows for higher profits but also increases risk exposure.

A servitization strategy requires providers to change their ways of doing business. The price focused, short-term mindset entailing one-off transactions makes way for new relational strategies with single supply sources based on trust that create constant streams of revenue.

Experiences from practice show mixed results on profit when firms increase their service activities.
Service activities on a small scale increased profitability, but medium levels of service activity diminished it. Only after large-scale operations are established does profitability start to grow again.

Risks Involved in Servitization