Asymmetric Information and Economies of Scale in Service Contracting
Manufacturing & Service Operations Management
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Firms increasingly use contingent labor to flexibly respond to demand in many environments. Labor supply agencies are growing to fill this need. As a result, firms and agencies are engaging in long-term contracts for labor supply. We develop mathematical models of the interaction between firms and labor supply agencies when demand and supply are uncertain. We consider two models of labor supply uncertainty, termed productivity and availability uncertainty, and study how each affects the nature of the contracts formed. These models reflect two major roles played by the labor supply agency. In the case of productivity uncertainty we find that it is possible to construct a contract that coordinates the firm and agency hiring in an optimal way. In contrast, we show that in environments characterized by availability uncertainty, optimal contracts are not possible. However, there is a large range of contract parameters for which both parties would benefit from a contract. We analyze these and discuss the trade-offs that should be considered in contract negotiation.