Co-production and Co-creation of Value: A Differential Games Approach

In this paper, we study the contracting issues in IT outsourcing projects. Our analysis also applies to other collaborative services, such as consulting, financial planning, and auditing. We consider that the client gets utility from the project throughout the development period since the software can be used as it is being developed by the vendor(s). The service output is contingent on the effort level of each party and we allow these effort levels to change throughout the planning period. Hence, the client firm needs to optimally decide on the terms to offer in the contract so as to maximize the service output and minimize its cost. We analyze the performance of different contracts and glean useful managerial insights. Moreover, we analyze two additional settings: (a) the vendor may lower its cost through training, and (b) the vendor or the client gets utility from the output even after the project finishes.