Two Is Better Than One: A Dynamic Analysis of Value Co-Creation

We study a setting where the nature of the collaboration necessitates two partner firms working together, which is often the case in supply chain and information technology (IT) environments. We consider that both firms get ongoing value from the project and the effort levels of both parties are dynamic. In this setting, one of the partners (say, the first partner) decides the terms of the payment it extends to the second partner in order to maximize the value it gets from the collaboration. We analyze the performance of output dependent, effort dependent, and hybrid (both effort and output dependent) payment structures, and find the best one under various scenarios. In particular, we find that if the output is relatively more sensitive to second party's effort, the hybrid payment structure should be preferred by the first partner. Furthermore, if the output is highly sensitive to second party's effort, the output-dependent payment structure yields more value to the first partner (compared to the effort dependent structure). We further find that the time that has passed in the collaboration and the length of the planning horizon affect the behavior of the effort levels and some other characteristics in the collaboration. We also study and derive interesting results in the following additional settings: the first partner or the second partner gets utility from the output even after the project finishes.