Performance-based contracting as an enabler of innovation

Organizations need to incorporate innovation into their businesses as the dynamic business environment is faced with globalization and large fluctuations in the economy. One of the ways to engage in innovation is through inter-organizational relationships. Unfortunately, interorganizational relationships frequently do not result in the expected performance and innovation. The primary way to govern inter-organizational relationships (IOR) is by means of a contract; yet, the majority of contracts are not conducive for innovation. A relatively new contracting type which is suggested to foster innovation is the performance-based contract. PBCs underline the outcome of the service rather than stating how to deliver it. As a consequence, PBCs leave more room for innovation. However, academic literature provides no guidance on how PBCs lead to innovation. By means of a literature review we develop a framework that outline how PBCs lead to innovation. We develop the statement that innovation hinges upon the collaboration between the partners, innovation incentives, and the provider’s autonomy, creativity, and risk. These factors are enabled by the contract duration (long-term) of a PBC, its (low) specificity level, and reward schemes. Finally, relationship orientation and providers’ risk averseness positively moderate the effects of contract duration on collaboration and providers’ risk on innovation respectively.