Using a proprietary data set provided by a major manufacturer of aircraft engines, we empirically investigate how product reliability is impacted by the use of two different types of after-sales maintenance support contracts: time and material contracts (T&MC) and performance-based contracts (PBC). We offer a number of competing arguments based on the theory of incentives that establish why product reliability may increase or decrease under PBC. We build a two-stage econometric model that explicitly accounts for the endogeneity of contract choices, and find evidence of a positive and significant effect of PBC on product reliability. The estimation of our model indicates that product reliability is higher by 25%-40% under PBC compared to under T&MC, once the endogeneity of contract choice is taken into account. Our results are consistent with two mechanisms for reliability improvement under PBC: more frequent scheduled maintenance and better care performed in each maintenance event. AbstractUsing a proprietary dataset provided by a major manufacturer of aircraft engines, we empirically investigate the impact of incentives present in after-sales repair and maintenance support contracts on product reliability. In particular, we compare the reliability of products under time and material (T&M) contracts, which have been used traditionally in the airline industry, with the reliability under performance-based contracts (PBC), which are gaining wide acceptance.We discover that there is inherent endogeneity in contract choices by the customers. To account for this endogeneity, we estimate a two-stage econometric model, and find that larger customers and users of certain equipment types are more likely to select PBC over T&M contracts. After controlling for this selection process, we find evidence for the positive and significant effect of performance incentives created by PBC on product reliability. Our estimates indicate an improvement of product reliability in the 10-25% range under PBC, compared to the reliability observed under T&M contracts. This finding is robust to numerous alternative specifications, modeling assumptions and estimation methods. Thus our research provides a valuable input into the ongoing policy debate about the effectiveness of performance contracts which are currently being introduced extensively in both the government and the private sectors.2

We study the impact of service attributes (warranty length, after-sales service quality) on consumer demand in the U.S. automobile industry, examining the presence of complementarities/substitution between service attributes and product quality. Our results estimate a median willingness to pay for one year of a warranty of approximately $850, which is equivalent to 3.1% of the median vehicle price in our sample. We find that, for a car with median characteristics, the effect on consumer utility of a 1% price decrease is equivalent, all else being equal, to increasing product quality by 2.2%, and is in turn equivalent to increasing the warranty length by 8%. Our results also indicate that service attributes play a compensatory role with respect to product quality; i.e., the impact of warranty length and service quality on demand increases when product quality decreases. Conversely, both service metrics are complementary with respect to demand; i.e., the better the service quality, the higher the marginal effect of longer warranties. Our results thus imply that, in our period of analysis, warranties played a more important role for American firms than for foreign firms, consistent with the fact that American manufacturers exhibited lower product quality and higher service quality than nonAmerican firms. We study the impact of service attributes (warranty length, after-sales service quality) on consumer demand in the U.S. automobile industry, examining the presence of complementarities/substitution between service attributes and product quality. Our results estimate a median willingness to pay for one year of warranty of about $850, which is equivalent to 3.1% of the median vehicle price in our sample. Wend that, for a car with median characteristics, the effect on consumer utility of a 1% price decrease is equivalent, all else being equal, to increasing product quality by 2.2%, and is in turn equivalent to increasing the warranty length by 8%. Our results also indicate that service attributes play a compensatory role with respect to product quality, i.e., the impact of warranty length and service quality on demand increases when product quality decreases. Conversely, both service metrics are complementary with respect to demand, i.e., the better the service quality, the higher the marginal effect of longer warranties. Our results thus imply that, in our period of analysis, warranties played a more important role for American firms than for foreign firms, consistent with the fact that American manufacturers exhibited lower product quality and higher service quality than non-American firms. AbstractWe study the impact of service attributes (warranty length, after-sales service qual-

Using a proprietary data set provided by a major manufacturer of aircraft engines, we empirically investigate how product reliability is impacted by the use of two different types of after-sales maintenance support contracts: time and material contracts (T&MC) and performance-based contracts (PBC). We offer a number of competing arguments based on the theory of incentives that establish why product reliability may increase or decrease under PBC. We build a two-stage econometric model that explicitly accounts for the endogeneity of contract choices, and find evidence of a positive and significant effect of PBC on product reliability. The estimation of our model indicates that product reliability is higher by 25%-40% under PBC compared to under T&MC, once the endogeneity of contract choice is taken into account. Our results are consistent with two mechanisms for reliability improvement under PBC: more frequent scheduled maintenance and better care performed in each maintenance event.

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