Organizations may view outsourcing as a way to manage risk. We developed a decision-analytic approach to determine which risks the buyer can share or shift to vendors and which ones it should bear. We found that allocating risks incorrectly could increase costs dramatically. Between 1995 and 1998, we used this approach to develop the request for proposals (RFP) for the US Department of Energy’s (DOE’s) privatization initiative for the Hanford tank waste remediation system (TWRS). In the model, we used an assessment protocol to predict how vendors would react to proposed risk allocations in terms of their actions and their pricing. We considered the impact of allocating each major risk to potential vendors, to the DOE, or to both and identified the risk allocation that would minimize the DOE’s total cost—its direct payments to vendors plus the costs of any residual risks it accepted. Allocating inappropriate risks to the vendor would have increased costs because the vendor would add a large risk premium to its bids, while allocating inappropriate risks to the DOE also would have increased costs because the vendor would not take adequate risk-reduction measures. With the improved risk allocation, the RFPs resulted in bids that were acceptable to the DOE.
Keisler, Jeffrey M.; Buehring, William A.; McLaughlin, Peter D.; Robershotte, Mark A.; and Whitfield, Ronald G., "Allocating contractor risks in the Hanford waste cleanup" (2004). Management Science and Information Systems Faculty Publication Series. 23.