Outcome-based contract performance and co-production in B2B maintenance and repair service

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Abstract This paper investigates co-production in a B2B Maintenance, Repair and Overhaul (MRO) service contract where the firm is tasked to deliver outcomes of MRO service rather than activities directly related to maintenance and repair. Our
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   1  Outcome-based Contract Performance and Co-production in B2BMaintenance and Repair Service 1   Ng, Irene C.L. 2  Xin Ding 3   The University of Exeter Business SchoolDiscussion Papers in ManagementPaper number 10/01ISSN 1472-2939  <under review at  Management Science>For interim citation: Ng, Irene C.L. and Xin Ding (2010), “ Outcome-based Contract Performance and Co-production in B2BMaintenance and Repair Service ”, Department of Management Discussion Paper series, University of  Exeter  1 This research was made possible through the joint funding of the Engineering & Physical Science ResearchCouncil (UK) and BAE Systems on the Support Service Solutions: Strategy & Transition (S4T) project consortiumled by the University of Cambridge. The authors gratefully acknowledge the staff of BAE Systems and MBDA aswell as members of the ADAPT IPT, 16 th Regiment, ATTAC IPT, MoD and the RAF who have all contributedsubstantially towards this research. 2 Professor Irene C L Ng is a Professor of Marketing Science at the University of Exeter Business School (U.K.),ESRC/AIM Service Fellow and Research Director of the S4T Grant Consortium, Institute of Manufacturing,University of Cambridge. Contact Information: University of Exeter Business School, Streatham Court, RennesDrive, Exeter EX4 4PU, United Kingdom Tel: +44 (0) 1392 263250, Fax: +44 (0) 1392 263242, Email:Irene.Ng@exeter.ac.uk    3 Professor Xin Ding is an Assistant Professor of Operations Management and Leadership Supervision at theUniversity of Houston (USA). Contact Information: Information and Logistics Technology Department, Universityof Houston, Houston, Texas, USA 77024 Tel: +1 714 743 4095 , Email:xding@uh.edu    2   Outcome-based Contract Performance and Co-production in B2B Maintenance and RepairService Abstract This paper investigates co-production in a B2B Maintenance, Repair and Overhaul (MRO) servicecontract where the firm is tasked to deliver  outcomes of MRO service rather than activities directly relatedto maintenance and repair. Our qualitative findings show that the promise of outcomes has extended the boundary of the firm to include the customer system within its responsibility. Such an inclusion results inthe allowance of customer variety into the firm’s system as the consumption of the service is contextualand varied. The ability to deliver the service in such an environment requires the firm’s operations process design to be extended beyond supply chain management for material/equipment transformation, but to include information and people transformation as well. In addition, the three transformations haveto be achieved in co-production with the customer. Through a quantitative study and Partial Least Squaresanalysis, the paper shows that outcome-based contract performance is dependent on the co-productionalignments of behaviors and information but not material/equipment, with the alignments partially driven by the co-production inputs of complementary competencies and congruence of expectations. Thisrelationship is further mediated by perceived control and empowerment of individuals co-producing theservice with the customer. Introduction Business-to-business (B2B) services have seen an explosion of growth over the last two decades, aided in part by technology and globalization. This growth includes the increasing tendency of firms to outsourcetheir activities to independent providers rather than delivering them in-house (Wilson and Smith, 1996).Many firms have found that specialized companies can now handle their internal services, for example,accounting, legal, recruitment or even R&D, much more effectively than they can do so themselves(Tschetter, 1987). Similarly, the maintenance, repair and overhaul (MRO) service of equipment are nowoutsourced to specialists that not only provide MRO services but often manage the supply chain,inventory and equipment obsolescence as well. As an indication, the world market for aircraft MRO isforecasted to reach US$55.2 billion by the year 2015, aided by the expanding Asian aviation market,upcoming airlines in the Middle East region and aircraft purchases by low cost carriers globally 4 . MROservices for other assets such as wind turbines (US$9 billion) 5 , shipping and other complex engineeringequipment are now significant contributors to national economies. Yet, there has been insufficientresearch into this domain that would typically include both engineering and management perspectives. In particular, the delivery of value in such contexts which include a combination of physical engineeredassets, people and processes has been inadequately studied (Maglio and Spohrer 2008; Basole and Rouse,2008).Our paper investigates the phenomenon of value co-creation and co-production in a B2B MRO servicecontract that delivers outcomes . Outcome-based contracting (OBC) is a contracting mechanism where thefirm is tasked to deliver  outcomes of an MRO service rather than merely activities and tasks directlyrelated to maintenance and repair. This is the case for Rolls Royce “Power-by-the-hour®” contracting for their aerospace engines, where the continuous maintenance and servicing of the engine is not paidaccording to the spares, repairs or activities rendered to the customer, but by how many hours the 4 "Aircraft Maintenance, Repair And Overhaul (MRO): A Global Market Report", Global Industry Analysts Inc., April 2009   5 “Growth Opportunities in Wind Maintenance, Repair and Overhaul Services Market 2008-2013”, Lucintel, Jan 2009     3 customer gets power from the engine. OBC poses huge challenges to the firm, as outcomes can only beachieved in co-production with the customer which implies that the firm would have to incorporate thecustomer’s processes and competencies into the firm’s system so that such outcomes could be delivered.MRO services is traditionally the domain of operations and supply chain management. However, our qualitative findings show that in outcome-based  MRO services, value is delivered through three forms of transformation – the transformation of material/equipment, transformation of information, andtransformation of behaviors (people) and in co-production with the customer, bringing in knowledge fromorganizational behavior and human resource management (OBHRM), strategy and marketing. The threetransformations are value drivers because the delivery of outcomes has extended the boundary of the firmto include the customer system within its responsibility. Such an inclusion results in the allowance of customer variety into the firm’s system, as the consumption of the service is contextual and varied.Through the understanding of value in marketing and by mapping value perceived by the customer ontodelivery, we found that the ability to deliver the service in a high variety environment requires the firm’soperations and delivery process design to be extended beyond mere functional logistic and supply chain processes for material/equipment but to include information and people transformation as well. Inaddition, the three transformations have to be achieved in co-production with the customer. To validateour qualitative study, our paper reports on a quantitative study conducted by applying Partial Least Square(PLS) analysis to investigate the firm-customer relationships in terms of co-production inputs, co- production alignments, intervening variables and contract performance, with confirmatory factor analysis(CFA) to evaluate our scales. The findings show that counter-intuitively, outcome-based MRO contract performance is not dependent on material/equipment process and supply chain alignment with thecustomer, since the firm is responsible for the outcomes of the equipment from their maintenance andrepair activities. However, behavioral and information alignment is essential for contract performance dueto the need to manage customer variety. Our results also show that all three alignments are driven by theco-production inputs of complementary competencies and congruence of expectations, and such arelationship is mediated by HR issues of perceived control and empowerment of individuals co-producingthe service with the customer. Through this study, our paper contributes towards the understanding of thetrans-disciplinary dynamics of delivery in a complex service system of physical assets, people and processes.This paper is organized as follows. A literature review setting out the study is presented next, to befollowed by the research context, design and administration. The qualitative study is then reported and itsfindings used to develop hypotheses for the quantitative study, supplemented with extant literature. Theresult of the quantitative study is then reported followed by discussions and conclusions. Literature Review Over the past few decades, manufacturing and engineering firms have contributed to growth in services inthe form of training, integration with clients’ capabilities, consultancy and other services related to the provision of equipment (Ren, 2009). Indeed, for many manufacturers to remain viable, research hasrecommended that they diversify into the provision of services, focusing on meeting the needs of equipment usage, instead of merely equipment alone (Neely, 2009; Baines et. al. 2007). This has led to anincreased need to understand the outcomes achieved by the combination of equipment, people and processes, and the nature of value consumed by the customer within a B2B context.In understanding the customer, B2B marketing has discussed the nature of business markets (e.g., Fill &Fill, 2005; Ulaga, 2001) and acknowledged it to be generally more geographically concentrated, reliant onthe derived demand of the customer’s markets and focused on relationships and personal selling (Cannon& Perrault Jr, 1999; Dwyer, Paul, & Oh, 1987; Moller & Aino, 1999). The organizational buying behaviour is more formalized and dependent on key influencers and decision makers (Sheth, 1996;   4 Webster & Wind, 1996). Literature in B2B also discussed channel organization, structure and networks(e.g. John, 1984), factors critical to success (e.g. Eid, Trueman and Ahmed, 2002), and managementstrategies in B2B environment (e.g. Webb, 2002). Channel management has also been covered in detail inmarketing (e.g. Jeuland and Shugan, 1983/2008; Coughlan et.al., 2001), with scholars using transactioncost economics (e.g. Klein, Frazer and Roth, 1990; Heide and John, 1990) and game theory (e.g. Jeulandand Shugan, 1983/2008) to describe cooperation and conflicts between channel members.From the marketing point of view, B2B research have traditionally focused on pre-purchase choice and buying behavior, a legacy of a goods-based environment where the responsibility of the firm often endswhen the customer has purchased the equipment or other industrial products (e.g. Wuyts and Geyskens,2005) as consumption of the good often does not involve the firm. Most of marketing’s focus on post- purchase in goods is therefore on maintaining customer relationships (e.g. Gadde and Snehota, 2000;Gronroos, 2004; Palmatier, 2008), leaving the realization of the firm’s value proposition (in the form of consuming the good) to the customer.However, many B2B contracts are now service contracts such as maintenance, repair and overhaul of equipment or professional services where the consumption of the service would now include the firm(Bolton, Lemon and Verhoef, 2008), and relationships are embedded in the processes and interactions of service delivery between the customer and the firm over a length of time. Hence in B2B services, thereneeds to be a greater concern about post-purchase interactions which would impact on value, customer relationships, future contracts and revenues (Bolton, Lemon and Verhoef, 2008). Vandenbosch andDawar (2002) demonstrated that managing customer interaction activities is a strong source of value tocustomers. Yet, current research often relegates the delivery of the firm’s value proposition in MROservice to the domain of operations and supply chain management (e.g. Harland et. al., 1999; Shapiro,Singhal and Wagner, 1993) We argue that in the context of B2B MRO service, knowledge in marketing,operations management and logistic/supply chain management must converge to align the firm towardsthe delivery of value to the customer for better relationships and for contract continuation. Customer relationship and co-delivery . B2B literature in marketing has had multiple discussions on buyer behavior. It is commonly accepted that the B2B buying decision process would include a buyingcenter and a selling center whereby the buying center includes all those within the customer firm that hasan influence over the buying decision e.g. the purchasing manager (who sources for suppliers), theengineer (who proposes the specification), the financial controller (who decides on payment terms).Conversely, the selling center includes those in the selling firm who assist in the sale e.g. the accountsexecutive, the technical manager, etc. (Sashi and Kudpi, 2001). In B2B services, due to the separation of  purchase and consumption (Ng 2008; Shugan and Xie, 2000), there is not only a buying center but also aconsuming center. Similarly, there is not only a selling center but also a delivery center. This implies thatservice delivery is not merely directed towards one person within a firm, but towards several individualsrepresenting the firm. The consuming community has an influence on the buying center at the contractingstage, but it is a challenge to understand what the value is for each member of the consuming community.This issue becomes all-important when a contract comes up for renewal and re-negotiation. Much of marketing literature that deals with customer value has not adequately considered how theconsuming/delivery community achieves the value promised, as this is traditionally the domain of operations literature (Karmarkar, 1996; Krishnan and Ulrich, 2001). Similarly, operations and supplychain literature, traditionally a cost center, has not adequately considered the impact of operationaldelivery/consumption on value perception which would impact on contract renewal (cf. Tan, 2001; Chenand Paulraj, 2004). Recent academic literature has called for integrated perspectives and approaches (Sosa,Eppinger and Rouse, 2004; Menor et. al., 2002).The concept of customer value has recently been considered using a relationship marketing perspective(Eggert, Ulaga & Schultz, 2006; Flint, Woodruff, and Gardial, 1997; Liu, Leach & Bernhardt 2005;   5 Payne & Holt, 2001; Gronroos, 2004). This view accentuates value creation within a relationship, asopposed to transaction-based exchanges. Such thinking has evolved into current ideas around the co-creation of value where resources (i.e. “people, systems, infrastructures and information” (Gronroos 2004)work together through processes to achieve the optimum benefit for the consumer. While much has beensaid about customer relationship management and relationship marketing within B2B, marketingresearchers have been reluctant to include service delivery within that domain. Since the relationship between the firm and the customer occurs at all levels of buying/selling and consuming/delivering,relationships are therefore not merely developed by customer relationship management systems, sales people or top management, but by every employee who interacts with the employees in the customer firm.The value of the contract, and the relationship with the customer, is therefore embedded within a complexsystem of delivery and use (cf. Normann & Ramirez, 1993). Value co-creation and co-production . Academic literature surrounding service delivery and consumptioncenters around the notion of  service encounter  for consumer services (Czepiel, Solomon and Surprenant1985; Bitner et. al., 1990). The service encounter is defined as all activities involved in the servicedelivery process (Bitner, 1990; Bitner, Booms & Mohr, 1994). Managers and service researchers describethis as the "moment of truth" to indicate the defining period when the interaction between the firm and buyer is of crucial importance to determine customer satisfaction (Bitner, Booms and Tetreault, 1990;Churchill & Surprenant, 1982; Anderson & Sullivan, 1993). The service encounter also embodies the co-creation of value, where the value is no longer  value-in-exchange (i.e. a tangible product solely createdwithin the firm and exchanged with the customer), but value-in-use , i.e. jointly co-created between thecustomer and the firm for benefits (Payne, Kaj, & Pennie, 2008; Prahalad & Ramaswamy, 2003). Theconcept of value co-creation subsumes previous service research in operations and strategy that haveemphasized the role of the customer within a service system such as the customer contact model (Chase& Apte, 2007; Chase & Tansik, 1983), customer interactions (Johnson, Manyika, & Yee, 2005) and valueco-production with the customer (Ramirez, 1999). In marketing literature, Bitner et. al. (1997) claims thatin co-creating value, customers could be partial employees, contributors to their own satisfaction andquality of the service and if customers choose to produce the service by themselves, they can becomecompetitors to firms. Within such thinking, recent researchers have proposed that firms do not really provide value, but merely value propositions (Vargo and Lusch, 2004) and it is the customer thatdetermines value and co-creates it with the firm. Hence, a firm’s product offering is merely valueunrealized until the customer realizes it through co-creation and gains the benefit. This has also beensuggested by Woodruff and Flint (2006) when they proposed that mutual satisfaction is dependent on bidirectionality . Gummeson (2008) suggested the term balanced centricity to illustrate this concept.Woodruff and Flint suggested that customers have an obligation to assess the needs of the provider and toassess resources to deliver these needs as part of the co-creation of value. In doing so, there is a need tounderstand the role of the customer in the firm’s processes and systems, and the role of the firm incustomer’s processes and systems. Extending this logic, this implies that it is not merely what resourcesand activities are contributed by each party but how both are aligned to achieve desirable outcomes andsecond, it isn’t merely good relationships between sales persons and top management of both firms thatneeds to be developed but also the appropriate behaviors and relationships between employees of bothfirms. Finally, if the delivery of a contract is consultancy, business processing, or MRO, the processes andsystem must be in place to deliver the core activities as well. All this implies that value co-creation andco-production in B2B MRO service contracts is a combination of processes, behaviors, information andequipment acted upon by both customer and firm employees in achieving contract outcomes. This is incontrast to the selling of tangible goods where production is without intervention of the customer andvalue-in-use realized by the customer is without any intervention of the firm.Our paper investigates the phenomenon of value co-creation and co-production in a B2B MRO servicecontract. MRO services is traditionally the domain of purchasing and supply chain management. Theincreasing importance of supply chain collaboration in corporate strategy is related to the belief that
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