Coordinating Project Outsourcing Through Bilateral Contract Negotiations

Abstract

Problem definition: Project outsourcing has been a pronounced trend in many industries but is also recognized as a major cause for project delays. We study how companies can coordinate outsourced projects with uncertain completion times through bilateral contract negotiations. Academic/practical relevance: Misaligned subcontractor incentives may result in substantial losses to both project clients and subcontractors. Coordinating subcontractors’ efforts through proper contracts is imperative to the success of project outsourcing. Most previous studies on project contracting have not addressed subcontractors’ bargaining powers or the dynamic bargaining process in negotiations. We fill in this gap by studying bilateral bargaining between the client and subcontractors, which better reflects real-world negotiations. Methodology: We model project contract negotiations as a multiunit bilateral bargaining game. We derive the conditions such that bilateral negotiations can achieve system coordination and characterize the equilibrium negotiation outcomes. We then compare the conditions and equilibria under various model settings to study their impact on project contracting. Results: Our study uncovers how the coordination of project outsourcing is impacted by the contract form, bargaining power structure, precedence network topology, payment timing, external opportunities, and negotiation protocols. For single-task projects, the widely used fixed-price (cost-plus) contract can achieve system coordination only when the subcontractor (client) possesses full bargaining power. Cost-sharing and time-based incentive contracts, which perform well for single-task projects, may not be effective for projects with parallel tasks when any subcontractor’s bargaining power is sufficiently high. Projects with serial tasks can be coordinated only under certain extreme bargaining power structures. Delaying payments always exacerbates the incentive misalignment. Managerial implications: Our analysis provides insights and guidelines to companies regarding how to select proper contract forms and payment timing schemes, based on the characteristics of the projects and subcontractors, to ensure the effectiveness of project outsourcing. Our results also highlight the importance of bargaining modeling in project contracting.