Abstract<br>While service outsourcing may benefit from the application of performance-based<br>contracts (PBCs), the implementation of such contracts is usually challenging. Service<br>performance is often not only dependent on supplier effort but also on the behavior of<br>the buying firm. Existing research on performance-based contracting provides very<br>limited understanding on how this challenge may be overcome. This article describes a<br><br>design science research project that develops a novel approach to buyer–supplier con-<br>tracting, using collaborative key performance indicators (KPIs). Collaborative KPIs<br><br>evaluate and reward not only the supplier contribution to customer performance but<br>also the customer's behavior to enable this. In this way, performance-based contracting<br><br>can also be applied to settings where supplier and customer activities are interdepen-<br>dent, while traditional contracting theories suggest that output controls are not effective<br><br>under such conditions. In the collaborative KPI contracting process, indicators measure<br>both supplier and customer (buying firm) performance and promote collaboration by<br><br>being defined through a collaborative process and by focusing on end-of-process indi-<br>cators. The article discusses the original case setting of a telecommunication service<br><br>provider experiencing critical problems in outsourcing IT services. The initial interven-<br>tion implementing this contracting approach produced substantial improvements, both<br><br>in performance and in the relationship between buyer and supplier. Subsequently, the<br>approach was tested and evaluated in two other settings, resulting in a set of actionable<br>propositions on the efficacy of collaborative KPI contracting. Our study demonstrates<br>how defining, monitoring, and incentivizing the performance of specific processes at<br><br>the buying firm can help alleviate the limitations of traditional performance-based con-<br>tracting when the supplier's liability for service performance is difficult to verify.
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