Risk Theory and Pricing of "Pay-for-Performance" Business Models

TL;DR

This paper introduces a novel risk theory and pricing model for performance-based business models like Pay-for-Performance, incorporating operational failure and financial risks to determine appropriate risk premiums.

Contribution

It presents a new model and calculation method for risk premium determination in innovative business models, considering operational failures alongside financial fluctuations.

Findings

Model effectively incorporates operational failure behavior.

Pricing simulation shows dependency on cost distribution.

Provides a practical approach for risk pricing in new business models.

Abstract

Technology trends as digitalization and Industry 4.0 initiate a growing demand for new business models. Most of this models requires a fundamental shift of operational and financial risks between seller and buyer. A key question is therefore how to include additional risk pricing and hedging. In this paper we propose a new approach for a risk theory of innovative performance based business models as "Pay-for-Performance" or "Product as a Service". A new model and calculation method for determination the risk premium is presented. It contains beside financial price fluctuations also operational failure behaviour of products. We apply the model for a typical industrial application and simulate the pricing dependency for different cost distributions.