Penalizing Lateness or Sharing Cost : Project Outsourcing via Request-for-Quote

Request-for-quote (RFQ) is the most common way for contractor selection, which is of vital importance to the success of project outsourcing. Project clients need to carefully design the RFQ mechanism to select and incentivize contractors properly. Problem definition: We study the RFQ design problem for project outsourcing by capturing the fundamental time-cost trade-off in project management. We consider two contract forms (cost-sharing and time-incentive) that are the most widely used in practice, combined with a simple fixed-term RFQ procedure. Methodology: We derive the optimal design of the above practical RFQ configurations based on a game theoretical model. Results: Our study shows that the cost-sharing contract can induce a higher work rate, shorter expected project completion time, and higher client payoffs. Nonetheless, the time-incentive contract brings higher system efficiency if the project's urgency to the client is low and achieves higher client payoffs if the client can only share the contractor's total cost (i.e., the sum of the direct and indirect costs) with the cost-sharing contract. We quantify the value of adding the time-incentive (cost-sharing) feature or using differentiated cost-auditing in RFQs. At last, we develop a closed-form bound on the relative decrease in the client's payoff by offering a fixed-term RFQ instead of the corresponding optimal mechanism. Managerial implications: Our result explains the prevalence of time-incentive contracts in public projects where system efficiency is appreciated. Besides, adding the cost-sharing feature or using differentiated cost-auditing may create considerable value for the client. Finally, our result suggests that project clients can avail themselves of the simplicity of a fixed-term RFQ procedure without sacrificing much profit