n‐Dimensional effectiveness metric‐compensating reward scheme in performance‐based logistics contracts

A paradigm shift is occurring in the relationship between suppliers and customers as the public sector continues to embrace the notion of Performance Based Logistics (PBL). There is now an increasing reliance on PBL concepts to define and monitor contractual relationships in both public and private industry. Successful PBL relationships are certainly faced with a number of challenges and difficulties. As uncovered by the work of Sols, Verma, and Nowicki [Eng Management J 19(2) (June 2007), 40– 50], the principle impediment to a successful PBL outcome is the proper formulation and mutual understanding, between supplier and customer, of the underlying financial reward/penalty model central to any PBL arrangement. The current state of the literature focuses on compensation structures based on only a single performance metric, which in most cases is insufficient to properly capture, reward, and penalize the supplier's performance. Instead, it is imperative to define and monitor multiple performance metrics to more accurately portray the performance the supplier is delivering in accordance to the customer's explicit expectations. This paper formulates an n ‐dimensional performance‐based reward model for use in PBL contracts. Each dimension corresponds to a performance metric and the n ‐dimensional reward model includes the notion of acceptable degree of variation in effectiveness (or, equivalently, a proportionality zone), of customer's acceptable compensation among metrics when there is overperformance for some and underperformance for others. An illustrative example is presented to show the applicability to PBL contractual relationships. © 2008 Wiley Periodicals, Inc. Syst Eng