Optimal service contract under cost information symmetry/asymmetry

AbstractService outsourcing has become a hot topic in both industry and academy. This paper studies the contract design problems for a service seller who consigns the service to a vendor. The vendor’s service cost parameter may or may not completely be known by the seller, which constitutes the cases of information symmetry or asymmetry. In both cases, the optimal contracts are developed to maximize the seller’s expected profit, with the consideration of contractible and non-contractible service qualities. The properties of the contract parameters are explored, along with the analysis of information rent and value of cost information. Moreover, we find that non-contractible service quality is not an issue for the service seller under cost information symmetry since a revenue-sharing type of contract can guarantee the seller’s profit. However, this result does not hold under cost information asymmetry and thus non-contractibility of the service quality indeed costs the seller.Keywords: service outsourcingservice qualityincentive theoryoptimal contract AcknowledgementsWe wish to express our sincerest thanks to the editors and anonymous referees for their constructive comments on the earlier versions of the paper. We also acknowledge the support of grants from National Natural Science Foundation of China (NSFC) No. 71372002 and Fundamental Research Funds for the Central Universities No. NKZXB1228 for Xiang. Li, and National Natural Science Foundation of China (NSFC) No. 71372100, and the Major Program of the National Social Science Fund of China, grant no. 13&ZD147 for Yongjian Li.Notes1 For those consumers of μ∈[0, (1)/(2)], they will not purchase the service since their utility of buying service would be Uμ(s, p)=μs−p=(μ−(1)/(2))s⩽0.