OUTSOURCING OF PRODUCTION: THE VALUATION OF VOLUME FLEXIBILTIY IN DECISION-MAKING

Background: Outsourcing remains a central mechanism for improving manufacturing supply chains, with volume flexibility being a frequently targeted objective. However, outsourcing decision-making remains focused on static cost estimations, while the value of volume flexibility is subject to managerial valuation, thus imposing a risk of estimation errors. This paper tests whether decision-makers systematically under- or overvalue volume flexibility when deciding on outsourcing. Methods: Four outsourcing decision made by an OEM operating with seasonality and boom and bust cycles are analyzed to assess if decision-makers' intrinsic valuation of volume flexibility is biased. This was done by utilizing a previously developed mixed integer linear programming model for tactical planning. The model jointly considers production planning, workforce adjustments and capital investment, while respecting upstream supplier constraints, thereby encompassing both positive and negative effects of production outsourcing on volume flexibility. Combining the model with detailed knowledge of how the production system would be impacted, enabled a quantification of the value from volume flexibility, which could then be compared to the decisions made. Results: Augmenting existing static cost estimations with the value of flexibility did not reveal systematic estimation errors. However, the results suggest that the value of volume flexibility is situational, and on average comparable to direct labor cost. Conclusions: The results emphasize the importance of accurately and case-specific valuation of volume flexibility in cost-driven production outsourcing.