Decision models for manufacturing outsourcing

Traditionally, in most industries strategic aspects of manufacturing outsourcing have been subordinate to tactical considerations. However, in the past decade, the need for considering the long-term and strategic goals of conducting business in a global multiple-partner environment has been magnified. Consequently, the complexity of making outsourcing decisions has increased. The currently available decision models do not take into consideration the most important and comprehensive strategic and tactical aspects of outsourcing. Therefore, in the first part of the dissertation, we propose a framework for making strategic manufacturing outsourcing decisions through developing a meaningful multi-factor decision model. Specifically, we advocate use of: (1) the value-focused thinking to identify the outsourcing objectives and the analytical hierarchy process to prioritize them, (2) a combination of the influence diagram and the decision tree to model the decision situation, and (3) the use of cumulative prospect theory as an alternative to traditional utility theory for modeling the risk behavior of the decision makers. In the second part of the dissertation a non-linear optimization model for the tactical outsourcing decision is formulated where the objective is to maximize the option value of engaging in manufacturing outsourcing. The model considers the revenue and the cost implications for each possible allocation scheme of insourcing and/or outsourcing to determine two optimal quantities: (1) the total quantity of product that the firm has to deliver to customers (through in-house manufacturing and/or outsourcing) to meet the aggregate demand and (2) the fraction of the total quantity that the firm should produce in-house and the fractions to be outsourced for each subcontractor while meeting the capacity constraints of the firm and its subcontractors. We take advantage of the option pricing theory to find an analytical solution to the optimization problem. The first proposed model is intended for use by management when they are considering the insourcing-outsourcing options. If the outcomes of this suggest engaging in the outsourcing process, then the management could employ the second decision model that practically selects the best outsourcing options at the tactical level