Using performance-based contracts to foster innovation in outsourced service delivery

While many scholars claim that Performance-based Contracts (PBCs) foster supplier-led innovation, empirical research into their actual use and effects remains limited. We therefore explore two cases of IT outsourcing through such contracts to see whether, and if so how, PBCs foster innovation. Our findings suggest that in both cases, the low degree of term specificity in PBCs (i.e., their openness regarding how to render the contracted services) provides suppliers with autonomy in their daily service operations, which in theory allows them to innovate. However, only one of the suppliers exhibited high innovative performance. Other relevant factors aside, our findings further suggest that a lack of granted autonomy during contract execution is an important factor in explaining the level of supplier-led innovation. Our findings imply that outsourcers that remain too closely involved with the outsourced service delivery and do not allow their suppliers to act autonomously during contract execution limit their suppliers' innovation potential.