The impact of fleet size on performance-based incentive management Hassan Mirzahosseinian 1,2 * , Rajesh Piplani 1 and Tongdan Jin 3 1 Nanyang Technological University, Singapore, Singapore; 2 The Logistics Institute- Asia Pacific, Singapore, Singapore; and 3 Texas State University, San Marcos, TX, USA Performance-based contracting (PBC) is envisioned to lower the asset ownership cost while ensuring desired sys- tem performance. System availability, widely used as a performance metric in such contracts, is affected by mul- tiple factors such as equipment reliability, spares stock, fleet size, and service capacity. Prior studies have either focussed on ensuring parts availability or advocating the reliability allocation during design. This paper investigates a single echelon repairable inventory model in PBC. We focus on reliability improvement and its interaction with decisions affecting service time, taking into account the operating fleet size. The study shows that component reliability in a repairable inventory system is a function of the operating fleet size and service rate. A principal-agent model is further developed to evaluate the impact of the fleet size on the incentive mechanism design. The numerical study confirms that the fleet size plays a critical role in determining the penalty and cost sharing rates when the number of backorders is used as the negative incentive scheme. Journal of the Operational Research Society (2016) 67(2), 165–175. doi:10.1057/jors.2015.52 Published online 8 July 2015 Keywords: reliability allocation; variable fleet size; service-level guarantees; performance incentive; product-service integration 1. Introduction After-sales support revenue represents 8–10% of the gross domestic product (GDP) in the US (the total GDP is $15.094 trillion in 2011). In public sector, the annual operation and sustainment cost for the US military alone is $63 billion, and the entire military fleet is maintained by 678 000 DoD personnel along with hundreds of private contractors (Smith, 2007). In wind power industry, the US installed wind capacity has increased by 309% between 2006 and 2011, and the worldwide installed capacity has grown 27% each year to reach 237 000 MW in 2011 (GWC, 2012). As a result, the maintenance and support market of the global wind generation is expected to reach $10.6 billion in 2016 with annual growth rate of 16.6% (Lucintel, 2013). Depending on the complexity of capital equipment, mainte- nance service can be subcontracted to the original equipment manufacturer (OEM) or a third-party logistics provider (3PL). In this study we assume that the OEM undertakes the after-sales support due to the complexity of the equipment and technology. Typical examples of such service include wind turbines, semi- conductor manufacturing equipment, computer servers, and air- craft engines. Material-based contracting (MBC) used to be the most common mechanism to provide maintenance services in equip- ment industry. In MBC, the OEM is compensated for the man hours and materials expended each time a service task is completed. Because of the simplicity in implementation, MBC has been widely used in private and public sectors for support- ing equipment operation and maintenance in the after-sales market. Nevertheless, under MBC the OEM has low motivation to improve the product reliability due to the fact that repair and maintenance generate a lucrative revenue steam post the warranty period. Lately, performance-based contracting (PBC) has emerged as a new service model redefining the acquisition, operation, and maintenance of capital equipment. A major advantage of PBC over MBC is the fact that the service provider under PBC is compensated based upon the deliv- ered system performance, not on the amount of man hours and spare parts consumed. Typical performance measures include system availability, equipment downtime, mean- time-between-failures (MTBF), and expected parts back- orders. In the long run, PBC motivates the OEM to improve the product reliability during design and manufacturing phase, as it will be paid off by reduced failures and repair costs post installation. At present, perhaps the largest PBC programme is the multi-national Joint Strike Fighter project in which $600 billion have been allocated to support the operation and maintenance of 2400 aircraft for the next *Correspondence: Hassan Mirzahosseinian, The Logistics Institute—Asia Pacific, National University of Singapore, 21 Heng Mui Keng Terrace, Singapore 119613, Singapore. E-mail: hmirza@nus.edu.sg Journal of the Operational Research Society (2016) 67, 165–175 © 2016 Operational Research Society Ltd. All rights reserved. 0160-5682/16 www.palgrave-journals.com/jors/