Subcontracting, Coordination, Flexibility, and Production Smoothing in Aggregate Planning

We propose a model in which subcontracting can be explicitly considered as a production planning strategy. Possible market and nonmarket subcontracting mechanisms and their costs are discussed. We show that a class of feasible subcontracting mechanisms in which firms coordinate their production via subcontracts Pareto-dominate other mechanisms. We then offer an example with quadratic cost functions and coordination subcontracts; linear decision rules for production, inventory, and subcontracting are derived. In the example, subcontracting reduces the variability in production and inventory. The same interpretation can be used for flexibility of manufacturing resources.